Vertical limit: what just happened?

The emergence of e-commerce in the bicycle market was an affront to almost every aspect of an industry business model that had for years thrived on handshakes, muffin-toting sales representatives and the seductive embrace of high margins. Though online stores had essentially evolved in full public view, a majority of the bicycle industry’s distributors and retailers were blindsided.

Imagine you own a beach house that’s been in the family for generations. The surf almost licks the front perimeter of your land boundaries. It’s always been like that. Recently though, researchers have compiled enough evidence to be certain sea levels will rise to the extent that the house will be under water in five years. Your options are clear:

1) react
2) do nothing

This is essentially the situation faced by the bicycle industry only a few years ago, as the first wave of online retailers arrived. Distributors with “watertight” supplier agreements (refer to previous article) probably felt secure that the rising tide wouldn’t venture onto their turf. If anything, this new paradigm acted as a catalyst for distributors to review their trading relationships and to push for modifications, ensuring product supply remained exclusively theirs. Identification of foreign threats became a priority; it became common practice in distribution offices for managers to spend 30-60 minutes trawling websites and forums for unauthorised (by their own qualification) supply channels before the business day began. Suspect sources would be reported back to the brand/supplier and assurances of a resolution would be received in good faith.

For retailers, the amount of online-sourced product in their market began as an annoying drip but evolved into a stream. Independent stores (i.e. those not part of a franchise or group) at the end of a very long supply chain, were powerless to act. Too small and capital-poor to demand better pricing terms, they could only hope their suppliers (distributors) would force online-exposed brands to close supply leaks. In cases that were systemic (for example, Shimano suffered pervasive grey market issues almost from the beginning of consumer e-commerce adoption), retailers expected re-calibration of market price and equitable spreading of the necessary margin reductions. With no other supply channels – despite grey market product being relatively easy to obtain, most retailers took a principled stance against this option – trust and hope was all they had.

The long supply chains that were for years held together by multiple independent parties operating in trusting unison, were by now seriously unravelling. Enormous amounts of OEM product, legitimately obtained or not, rapidly eroded the goodwill and trust – those long-serving pillars of the bicycle industry – along the entire supply chain. All parties were potential conduits.

For the moment, this was a problem limited to bicycle parts. The bicycle market, particularly in developed, mostly Western markets, had been trending away from frameset sales in favour of complete bicycle sales. The bicycle brand’s rationale was to better serve busy retail customers that had grown accustomed to expedient transactions – why spend hours putting together a custom-built bike when it’s easier to sell one out of the box at a higher profit? Giant led the way in this regard. It could take a mechanic with basic technical competence as few as 15 minutes to assemble a boxed bike into one that could be ridden away.

Ironically, this move to complete bicycles swelled the volume of OE parts flowing into Taiwan and, subsequently, the volume of OE parts left over at the end of each seasonal cycle. Not only that, the act of bolting on parts to a frameset caused a dilutive effect by association. Consumers developed a simple price-ceiling formula for a complete bike: maximum bike price = cheapest frameset price + cheapest price for same parts sourced online – discount for buying everything together. It was therefore a disadvantage for a bicycle manufacturer/brand to not offer framesets individually (most retained halo frame sets in their arsenal), as it left the equation incomplete and incentivised consumer bargaining. [Scott Bikes, having built a solid reputation for carbon fibre innovation and fabrication competency, understood the value of framesets. Scott routinely trickled new platforms down the product range, thereby retaining the perceived halo value from the first year of that frame set’s lifecycle – the Scott CR1, for example, was introduced as a professional-level platform, then gradually eased downwards over several years (and through various specification iterations) into a mid-level bike for enthusiasts.] So, cheap parts were in abundance and this materially changed the value perception of bikes they helped to complete.

Online retailing was initially (and still is in some sectors of the bicycle industry) construed as illegitimate business. It’s true that some first-generation online traders had formed alliances with self-serving OEM agents to secure grey market parts supply – a frustrating scenario for low-tech suppliers who were often unable to isolate the source – but legitimate OE procurement channels existed for “e-tailers” with sufficient capital to buy bulk OE product from suppliers who either didn’t have a distributor in a given market, or simply stopped caring about exclusivity.

E-commerce also gave rise to another phenomenon; the “house brand” bicycle. As mentioned in ‘Vertical limit | the long and short of bicycle manufacturing’, Original Design Manufacturers (ODM’s) design and produce bicycle frames and accessories, then sell that product to independent companies that brand, market and sell it. This graph illustrates the possibility for bicycle distributors or retailers to purchase an unbranded frameset directly from a factory, brand it then sell it. However, there were far more interesting opportunities than simply selling framesets with your name on it; namely, access to OE parts and purchasing equity.

Scenario – bicycle retailer turns legitimate brand creator
It’s 2005. Steve’s Bikes, an inner-city bicycle retailer has operated successfully and profitably for many years. Sensibly, Steve has diverted as much profit into savings as he has into his business. Although he loves work and can’t envisage retirement for at least another decade, he is concerned about the stiff competition he faces from overseas retailers. He is ghost-shopped by consumers constantly. Additionally, margins of complete bicycle brands he stocks have diminished due to his distributor appointing new dealers in neighbouring suburbs; everyone is discounting to secure a bicycle sale.

Feeling deserted by his suppliers and entitled to “play the game”, Steve decides to contact an industry acquaintance in Taiwan that he bumps into almost every year at the annual Taipei Cycle trade show. The contact, a sales manager at ‘BikePower’ ODM factory, informs Steve that the timing of his email is good. BikePower can offer Steve a small quantity of carbon or aluminium frames, equipped with first-tier branded parts. As BikePower makes bikes for many brands, they access these parts at OEM list prices or lower. The sales manager inquires whether Steve also wants BikePower to help with the graphic design and branding – as they have recently formed a small in-house design team.

Steve chooses a brand name – ‘SBike’ – and, a few months later, the first shipment of bikes is delivered to his store. Having spent time ensuring the bikes presented well, Steve’s aggressively-priced bikes sell above expectations. He has responded to upstream supply threats by developing his own legitimate bicycle brand that can compete against local market price and specification benchmarks.

Learsport, Cell Bikes and Novara are just three examples of distributors and/or retailers who have ventured down this path. They also continue to co-operate with industry peers who still follow the more traditional supply model, proving progression doesn’t necessarily beget elimination. [This will be covered in the final article of this series]

Scenario extension – bicycle retailer turns grey market traderOver time, many of Steve’s Bikes suppliers (local distributors) feel threatened and stop supplying Steve their imported bicycles and parts. It’s perceived that Steve is focused solely on selling his SBike bicycles while their more expensive bikes gather dust. Emboldened by his independence and with nothing to lose, Steve embarks upon another project – an online store. BikePower can supply him a basic aluminium-framed bicycle with almost any branded OE parts he chooses. Once the bikes arrive at his store, the parts can be stripped and sold individually at prices far lower than retail. Steve doesn’t inform BikePower that he intends to do this, as it’s likely they would not supply under these circumstances; indeed, such an intentional supply could even threaten BikePower’s supply of parts from the manufacturers concerned.

By selling unauthorised OE parts online Steve has now strayed into a grey market tract, forcing his former industry peers into a lengthy campaign to contain the detrimental optics plaguing their once well-regarded, and exclusive, imported brands.

Whilst distributors feared an authorised (parallel) supply of branded product into their market the most – as this would underpin a material change in import exclusivity and probably revenue loss – the grey market scenario was commonly linked with e-commerce when the first waves arrived. In the final article of the ‘vertical limit’ series, we’ll explain how manufacturers are co-operating with e-tailers (and have been for years) and question how multiple supply channels can co-exist into the future.